Integrated Mini Case for Chapter $10$: Loan Analysis

As a senior loan officer at MC Bancorp, you have the following loan applications waiting for

review. The bank uses Altman's Z score, default probabilities, mortality rates, and RAROC to

assess loan acceptability. The bank's cost of equity $($the RAROC benchmark$)$ is $8$ percent. The

bank's loan policy states that the maximum probability of default for loans by type is as follows:

Which of the following loans should be approved and which rejected?

An AAA$-$rated, one$-$year C&I loan to a firm with a liquidity ratio of $2\mathrm{.}25,$ a debt$-$to$-$asset

ratio of $55$ percent, volatility in earnings of $0\mathrm{.}12,$ and a profit margin of $11$ percent. MAC

Bancorp uses a linear probability model to evaluate AAA$-$rated loans as follows:

$PD=-0\mathrm{.}08x_1+0\mathrm{.}15x_2+1\mathrm{.}25x_3-0\mathrm{.}45x_4$

where

$x_1=$ Liquidity ratio

$x_2=$ Debt$-$to$-$asset ratio

$x_3=$ Volatility in earnings

$x_4=$ Profit margin